The Bank of England has warned of a “significant” threat from a sharp rise in interest rates to debt-laden households, banks and finance firms.
In its quarterly financial stability report, the Bank called for City regulators to assess how vulnerable borrowers and financial institutions will be to a sharp rates rise and report back in September.
The Bank warned that borrowers would face “significant distress” and “risks could crystalise” if global long-term interest rates were to rise from their current historic lows.
UK borrowers currently benefit from the lowest interest rates on record, with the Bank’s base rate stuck at 0.5 per cent since 2009, while other central banks around the world have also pushed rates to record lows. This has allowed cash-strapped households to keep on top of mortgage repayments, despite a fall in real incomes, with lenders also relaxing debt demands through forbearance.
The Bank said: “The significant cohorts of UK borrowers could experience financial difficulties if interest rates were to rise during a period of subdued income growth.
“A rise in interest rates without a strengthening in income could significantly increase borrower distress and losses to banks.”
It added that UK household debt remains high as a proportion of income at around 140 per cent, with UK bank lending to households and non-financial firms at around £1.4 trillion.
About 9 per cent of UK mortgage holders will have to take action – such as working longer hours, cutting back on essentials and changing mortgages – if rates were to rise by just one percentage point, it said.
Sir Mervyn King warned in his last public appearance as governor yesterday that many homeowners in their thirties and forties would not survive if interest rates returned to normal.
He said: “I think the idea we are about to return to normal levels of interest rates is premature, and one of the reasons we are not about to return is precisely because so many households have such a high level of household debt.”
A rise in rates could increase bad debt losses at banks, the Bank said yesterday, as well as increase their funding costs.
A two percentage point rise in rates would force 20 per cent of mortgage borrowers to “take actions to afford debt payments”, the Bank added.
It also said some heavily indebted firms, such as property companies, remained particularly vulnerable. It said commercial property loans accounted for about 40 per cent of banks’ corporate loans.
“The most highly leveraged firms have not deleveraged in recent years,” it said.
The Bank ordered the Financial Conduct Authority and the Prudential Regulation Authority to report back to its financial policy committee by September on the risks of a sharp rates rise.
Global stock markets have plunged heavily in recent weeks over the US Federal Reserve’s plans to reduce its quantitative easing drive.
The Bank said some partial adjustments of low interest rates had taken place already – possibly in anticipation of changes in monetary policy.
It said: “Low global interest rates are supporting financial markets. Expectations about any of the drivers of low interest rates could change rapidly and cause an abrupt adjustment to financial market prices.”